'Claims that negative screening hurts sin stocks are somewhat overstated,’ say authors
Investors who eliminate sin stocks from their portfolios in hopes of hurting the companies’ valuations and access to cash may be dissatisfied with the results.
According to a study titled "Does ESG negative screening work?" people and institutions have long assumed that avoiding a company's stock has a detrimental effect on that company's financial success. However, there is no evidence to support this belief.
The study was conducted by Robert Eccles, a visiting professor at Oxford University's Said Business School; Shiva Rajgopal, a professor at Columbia Business School; and Jing Xie, an assistant professor at Hong Kong Polytechnic University, reported Institutional Investor.
Eccles, Rajgopal, and Xie discovered that, compared to non-sin stocks of businesses with comparable fundamentals, negative screening for sin stocks has no impact on the firms' valuations, stock prices, exits, and returns.
“In sum, we argue that claims that negative screening hurts sin stocks are somewhat overstated,” the trio wrote. “The underlying empirical reality, at least since 2000, is more nuanced and complicated and depends on the research design used.”
In negative screening, investors exclude equities from their portfolio that they believe to be unethical or unsustainable considering governance, social, or environmental considerations.
As an example, many institutional investors search for "sin stocks"—stocks of businesses that make goods that are damaging for both people and the environment, such as those associated with alcohol, cigarettes, gaming, and, more recently, fossil fuels.
Certain industries have been avoided by institutions for a long time, resulting in lower stock holdings in these businesses.
The difference between institutional ownership of non-sin stocks and sin stocks climbed from 4.3% in the first decade of the millennium to 7.9% from 2010 to 2019, which is consistent with the paper's assertion that negative screening has only become worse over the past ten years. Negative screening is mostly focused on the alcohol and firearms sectors.
The authors compared the impact of negative screening on sin stocks and non-sin stocks when the underlying companies had the same fundamentals to assess the efficacy of these strategies and determine whether excluding sin stocks from institutional portfolios hurt the companies that promote the unethical products. As a result, both groups of companies had comparable sizes, ages, returns on assets, risk profiles, historical results, stock-price-based dividend yields, and book-to-market ratios.
The authors' analysis is based on the notion that if avoiding these companies has adverse effects on the industries that are excluded, the errant firms should have lower valuations than non-sin equities when their firms' other features are the same.
This doesn't seem to be the case, though. The authors discovered that the firm's valuation was unaffected by negative screening for sin stocks.
According to the report, negative screening for sin stocks did not lead to reduced offer prices for such equities as compared to other stocks. Positive stock returns also do not follow bad news concerning sin stock businesses that alter investors' assessments of the company's ESG performance.